$52.9 billion.
That's the total revenues net of interest expense Amex
made in 2022.
But despite its impressive earnings, Amex is far from
dominating the credit card industry.
Its domestic payment volume is far behind that of Visa
and MasterCard, and it lags behind Discover based on the
number of cards in circulation.
It's a difficult business for American Express to be
in, given the threats posed by Visa and MasterCard.
What they've leaned into are people who use the card a
lot, spend a lot of money, and pay it off, and they're
willing to cater to that crowd by giving them premium
perks, whether that's at the airport or things they
can use every day.
Whether that's a Walmart plus membership or Uber cash
or things that keep you using that card, keep it at
the top of your wallet.
Armed with impressive rewards and a loyal customer
base, Amex has achieved impressive growth.
The company's revenue has increased over 32% since
2017 and shares of the company have shown
resilience and growth in a tumultuous market.
Amex, I would think of them as a bit more of a what we
call a quality compounder, like a very steady, stable
business. Growing revenues, high single-digit to 10% and
then they get a little bit of operating leverage on top
of that. They grow earnings in the low double digits.
They've learned a lot through COVID.
They've diversified their business model.
They've sharpened their pencils on what matters to
their customers. And it's really showing and they're
coming back strong.
So what is the secret to Amex's success and where is
it headed next?
American Express began as a freight forwarding company
in 1850, transporting various goods across a
rapidly expanding nation.
It wasn't until the late 19th century that it began
its transformation into a payments company.
It began to introduce financial products and
travel services.
Then, in the 1950s, following its high success
from traveler checks, it introduced its first charge
card to offer customers a more convenient way to pay.
Where the brand truly begins as we know it today, in my
opinion. You know, they've had multiple products come
out, the gold card, the platinum card, and really
focusing on the consumer and the corporate card
business.
What sets Amex apart from the rest of the industry is
the way in which their network operates.
Most credit cards from companies like Visa and
MasterCard function in what's called an open-loop
system. When a cardholder uses the card in their
network to make a purchase from a merchant, they
generate revenue by relaying that information
from the issuers, usually the banks that have issued
the cards to the acquirers, or the merchant's Bank.
Amex, on the other hand, operates in a closed-loop
system where it functions as the issuer, the acquirer,
and the network combined.
Amex is different from Visa and MasterCard because Amex
is a lender.
Visa and MasterCard are merely card networks, so
they process transactions, but they're not actually
issuing credit.
American Express is both.
They are a lender of credit and also a card network, a
processor of transactions.
That really enables them to see exactly what their
customers are spending down to the item and have all
that extra data where they can then advertise or target
different reward spans across that.
That's going to be very different than what Visa and
MasterCard can see, which would be just really total
dollar amounts.
It allows them to tailor some of those deals,
especially on the merchant side.
If there's a reason why they want a specific
merchant's business, they can change their normal
terms in order to fit that situation.
They don't have to worry about a bank being upset
about what those terms are, whereas Visa and
MasterCard would.
This closed-loop system also allows Amex to earn money
from interest, unlike Visa and MasterCard.
The company generated about $9.9 billion in net interest
income in 2022.
It's advantageous to be diversified.
So they get paid any time a transaction is processed and
then there are also other levers like people who pay
annual fees or carry debt or other things that incur
charges.
But interest income is just the tip of the iceberg when
it comes to Amex's total revenue.
Discount revenues, or fees charged to merchants that
accept its cards brought in more than $30 billion in
2022, contributing to more than 58% of Amex's total
revenue net of interest expense for that year.
They charge a premium to their merchants to take
their cards, and the merchants are willing to pay
that premium because American Express is bringing
them the most affluent, biggest spenders.
They make the discount revenue off of the swiping
and so they charge the merchants a certain discount
rate, two and a half or so, it depends.
This can vary by merchant size, actually, but a lot of
their revenue, unlike their competitors, is coming from
this swipe fee versus net interest income.
Because of its reliance on discount fees, big spenders
are Amex's most important asset.
Recent reports claim that Amex card members spend, on
average three times as much annually as those who aren't
members. Amex targets these affluent cardholders through
a spend-centric model that focuses on generating
revenues primarily by driving spending on its
cards. That's where rewards come in.
In just 2022, Amex spent almost $17 billion providing
services and rewards to its card members.
When they talk about a spend-centric model.
They're really talking about being your go-to card.
And I think a really good example of this is the Amex
Platinum Card, one of their flagship premium products.
On the face of it, this is a travel card and it has a
lot of travel benefits with rewards and airport lounges
and all that fun stuff.
But you can also get a free Walmart plus membership and
you can get a whole bunch of other everyday kind of
credits. They're trying to make this a go-to, every
day, not just something that you pull out a few
times a year when you're traveling.
That high spend-centric model is the reason why they
can provide such strong rewards that they do and why
the customers are willing to pay those higher annual
fees than for other cards because they're getting the
benefits of the spend and the rewards.
Because the people that are spending are actually making
this up in their spend behavior.
Having a closed-loop system means how much the
cardholder spends is usually more important than
the number of transactions made.
Amex also utilizes the immense information gathered
through its closed-loop system to create offers that
attract and retain customers.
A lot of the tricky part about rewards programs in
kind of big, kind of more mainstream cards is that the
rewards are a little bit of like ad hoc, like they might
have very cool, interesting rewards, but they might not
be things that you as a consumer value.
In American Express's case because of that closed-loop
dynamic and because they know you and they know the
merchant, they can create rewards that feel to you as
the consumer, like this program was custom designed
for me. Like they can go out and recruit all of the
top hotels and all of the top restaurants and have
specialized offers and specialized rewards and
stuff to bring consumers, the affluent consumers, to
those hotels, to those restaurants. And everyone
sees benefits from their role in the middle of
connecting those dots.
Having an affluent customer base also gives the bonus
advantage of decreased credit risk.
Delinquency rates for Amex have remained substantially
lower compared to other major issuing banks.
Credit losses through the cycle will move really
closely with unemployment, as you would expect.
If you think about the changes in unemployment,
they roughly go up between 1.7 times and 2.25 times in
a recession, and the prime credit card issuer will see
roughly that same sort of increase in credit losses
over that time frame, whereas an American Express
could actually see a little bit less than that.
So if it was to go up two times, you might see
American Express go up 1.8 times.
And so that makes a big difference as far as the
cyclicality of the business, the overall risk
to earnings, and returns.
It's really one of the reasons why investors kind
of focus on this stock in a downturn.
It's considered a safety play and that's why we're
outperformed with the stock today.
In recent years, Amex has begun to diversify its
customers further, mainly targeting millennials and
underbanked Americans.
I really think that Amex is doing a good job winning
over younger customers as well.
They've talked about how about 60% of their new card
acquisitions are Gen Z and Millennials, and I think
they've done some creative things there with
experiences, whether it's travel or dining or
exclusive concerts, like they did one with Jack
Harlow. And, you know, they're just trying to reach
a younger audience that will be the leaders and
heavy spenders of tomorrow.
Amex has also made meaningful investments in
scaling and improving its technology, allowing its
offerings to be more competitive against the rise
of alternative premium cards.
They continue to make progress abroad.
They were actually the first US based credit card
issuer to win approval in China, and they're
partnering with local brands there to really tap
into that increasingly affluent consumer audience.
In Europe, this is like France, Germany, credit card
adoption, both by affluent consumers and by small
businesses, is much lower, much lower than it is, say,
in the US, the UK and Australia, where it's quite
high. And so there's a huge amount of just growth
opportunity.
I think increasingly they're also tech companies in a way
that whether that's the apps and the web experiences
that they provide or all of the data that they're
gathering. You know, some people say that a concept
like buy now, pay later could be a big threat to the
Amex model.
They actually were the first traditional credit
card issuer to unveil their version of that.
A few years ago, they came out with Amex Pay It Plan
It, which I think again speaks to offering something
for everybody.
The biggest threat for Amex is the competition within
the credit card industry.
To me, the biggest weakness or danger for American
Express really is that marketplace power of Visa
and MasterCard and what they may decide to do with
it, which may or may not be anything that American
Express can control.
The value that they are able to offer from the
closed-loop model is distinctive and unique.
But as things like data analytics and AI get
better and the whole process of issuing cards and
managing card programs becomes more digitized, as
their technology advances, those open-loop card
programs can better replicate what American
Express is able to do uniquely.
So they can run better analytics to understand your
consumer spending so they can better tailor your
rewards.
But while loan loss provisions have increased
following a period of high inflation, experts believe
that Amex is more than ready to weather a possible
recession.
They're not by any means immune to a downturn.
But at the same time, with that high-spender affluent
customer, those credit losses are likely
significantly lower than some of the peers that are
more focused on average consumer, even subprime
borrowers. And so there's no reason to think that
American Express won't have a strong customer base after
the next recession.